Why a Bottle of Beaujolais is not the same as a Collateralized Debt Obligation (Updated May 2016)

I have updated this blogpost with a link to the new version of my paper. The new revised paper has the title of "Pricing Assets in an Economy with Two Types of People". 

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Brad DeLong kindly tweeted a link to a working paper (updated to new version May 21st 2016) I wrote last year. Matt Yglesias asks Brad to explain the paper. Let me take a stab at that.

Every graduate student of economics learns, early in her career, that markets work well. The idea that ‘markets work well’ has a well defined meaning: allocating resources by buying and selling goods in free markets does at least as well as any other way of allocating them. Let me be more precise.

A society, to an economist, is a bunch of people and a bunch of goods. A good is something that people want. For example, a ticket to see the latest Star Wars movie is a good. A bottle of Beaujolais is a good: and so is a banana. I could go on. But the basic idea here is that everyone in society has preferences over different bundles of goods. I personally would prefer a bottle of Beaujolais and a banana to a trip to the movies: but you may rank things differently.

Scott Sumner and Musical Chairs

Since 2009, Scott Sumner has been a big proponent of nominal GDP targeting. He sees nominal wages as slow to adjust and he has sketched a simple model, the musical chairs model, to explain why his policy should be adopted.

I am a new convert to these arguments. That is my loss. I had assumed, incorrectly, that Scott was proposing that central banks should simply adjust the coefficients on their interest rate policies, so called Taylor Rules, to raise the nominal interest rate when nominal GDP growth is above target and to lower it when nominal GDP growth is below target.I will refer to that variant of NGDP targeting, as growth rate targeting. An alternative, NGDP level targeting, would make these interest rate adjustments in response to deviations of nominal GDP from a target growth path. For an elaboration of that view, see, for example, the article by Evan Koenig, Vice President of the Dallas Fed.